Hostname: page-component-77c89778f8-cnmwb Total loading time: 0 Render date: 2024-07-22T16:49:42.489Z Has data issue: false hasContentIssue false
  • English
  • Français

Do Hedge Funds Reduce Idiosyncratic Risk?

Published online by Cambridge University Press:  23 January 2015

Namho Kang ,
Péter Kondor  and
Ronnie Sadka
Namho Kang
Affiliation:
namho.kang@business.uconn.edu, School of Business, University of Connecticut, 2100 Hillside Rd Unit 1041, Storrs, CT 06269
Péter Kondor
Affiliation:
kondorp@ceu.hu, Department of Economics, Central European University, Nador u 9, Budapest, H-1051, Hungary
Ronnie Sadka
Affiliation:
sadka@bc.edu, Carroll School of Management, Boston College, 140 Commonwealth Ave, Chestnut Hill, MA 02467.
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper studies the effect of hedge-fund trading on idiosyncratic risk. We hypothesize that while hedge-fund activity would often reduce idiosyncratic risk, high initial levels of idiosyncratic risk might be further amplified due to fund loss limits. Panel-regression analyses provide supporting evidence for this hypothesis. The results are robust to sample selection and are further corroborated by a natural experiment using the Lehman bankruptcy as an exogenous adverse shock to hedge-fund trading. Hedge-fund capital also explains the increased idiosyncratic volatility of high-idiosyncratic-volatility stocks as well as the decreased idiosyncratic volatility of low-idiosyncratic-volatility stocks over the past few decades.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 49 , Issue 4 , August 2014 , pp. 843 - 877
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2015 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Allen, F. “Do Financial Institutions Matter?” Journal of Finance, 56 (2001), 1165–1175.Google Scholar
Amihud, Y. “Illiquidity and Stock Returns: Cross-Section and Time-Series Effects.” Journal of Financial Markets, 5 (2002), 31–56.Google Scholar
Ang, A.; Hodrick, R. J.; Xing, Y.; and Zhang, X.. “The Cross-Section of Volatility and Expected Returns.” Journal of Finance, 61 (2006), 259–299.CrossRefGoogle Scholar
Aragon, G. O., and Strahan, P. E.. “Hedge Funds as Liquidity Providers: Evidence from the Lehman Bankruptcy.” Journal of Financial Economics, 103 (2012), 570–587.CrossRefGoogle Scholar
Bekaert, G.; Hodrick, R. J.; and Zhang, X.. “Aggregate Idiosyncratic Volatility.” Journal of Financial and Quantitative Analysis, 47 (2012), 1155–1185.Google Scholar
Ben-David, I.; Franzoni, F.; and Moussawi, R.. “Hedge Fund Stock Trading in the Financial Crisis of 2007–2009.” Review of Financial Studies, 25 (2012), 1–54.CrossRefGoogle Scholar
Boyson, N. M.; Stahel, C. J.; and Stulz, R. M.. “Hedge Fund Contagion and Liquidity Shocks.” Journal of Finance, 65 (2010), 1789–1816.CrossRefGoogle Scholar
Brandt, M. W.; Brav, A.; Graham, J. G.; and Kumar, A.. “The Idiosyncratic Volatility Puzzle: Time Trend or Speculative Episode?” Review of Financial Studies, 23 (2010), 863–899.Google Scholar
Brunnermeier, M. K., and Pedersen, L. H.. “Market Liquidity and Funding Liquidity.” Review of Financial Studies, 22 (2009), 2201–2238.Google Scholar
Bushee, B. J., and Noe, C. F.. “Corporate Disclosure Practices, Institutional Investors, and Stock Return Volatility.” Journal of Accounting Research, 38 (2000), 171–202.Google Scholar
Campbell, J. Y.; Lettau, M.; Malkiel, B. G.; and Xu, Y.. “Have Individual Stocks Become More Volatile? An Empirical Exploration of Idiosyncratic Risk.” Journal of Finance, 56 (2001), 1–43.Google Scholar
Coval, J., and Stafford, E.. “Asset Fire Sales (and Purchases) in Equity Markets.” Journal of Financial Economics, 86 (2007), 479–512.Google Scholar
Danielsson, J.; Shin, H. S.; and Zigrand, J.. “The Impact of Risk Regulation on Price Dynamics.” Journal of Banking and Finance, 28 (2004), 1069–1087.Google Scholar
Fama, E. F., and French, K. R.. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, 33 (1993), 3–56.CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “Industry Costs of Equity.” Journal of Financial Economics, 43 (1997), 159–193.CrossRefGoogle Scholar
Fama, E. F., and MacBeth, J.. “Risk, Return and Equilibrium: Empirical Tests.” Journal of Political Economy, 81 (1973), 607–636.CrossRefGoogle Scholar
French, K. R. “The Cost of Active Investing.” Journal of Finance, 63 (2008), 1537–1573.CrossRefGoogle Scholar
Friedman, M. Essays in Positive Economics. Chicago, IL: University of Chicago Press (1953).Google Scholar
Gamboa-Cavazos, M., and Savor, P. G.. “Holding on to Your Shorts: When Do Short Sellers Retreat?” Working Paper, Temple University (2014).Google Scholar
Gaspar, J., and Massa, M.. “Idiosyncratic Volatility and Product Market Competition.” Journal of Business, 79 (2006), 3125–3152.CrossRefGoogle Scholar
Getmansky, M.; Lo, A. W.; and Makarov, I.. “An Econometric Model of Serial Correlation and Illiquidity in Hedge Fund Returns.” Journal of Financial Economics, 74 (2004), 529–610.Google Scholar
Greenwood, R., and Thesmar, D.. “Stock Price Fragility.” Journal of Financial Economics, 102 (2011), 471–490.Google Scholar
Guerrieri, V., and Kondor, P.. “Fund Managers, Career Concerns, and Asset Price Volatility.” American Economic Review, 102 (2012), 1986–2017.Google Scholar
Hong, H.; Kubik, J. D.; and Fishman, T.. “Do Arbitrageurs Amplify Economic Shocks?” Journal of Financial Economics, 103 (2012), 454–470.CrossRefGoogle Scholar
Irvine, P. J., and Pontiff, J.. “Idiosyncratic Return Volatility, Cash Flows, and Product Market Competition.” Review of Financial Studies, 22 (2009), 1149–1177.CrossRefGoogle Scholar
Jylha, P.; Rinne, K.; and Suominen, M. J.. “Do Hedge Funds Supply or Demand Liquidity?” Review of Finance, 18 (2014), 1259–1298.Google Scholar
Koch, A.; Ruenzi, S.; and Starks, L.. “Commonality in Liquidity: A Demand Side Explanation.” Working Paper, University of Pittsburgh (2009).CrossRefGoogle Scholar
Kondor, P. “Risk in Dynamic Arbitrage: Price Effects of Convergence Trading.” Journal of Finance, 64 (2009), 638–658.CrossRefGoogle Scholar
Lamont, O., and Stein, J.. “Aggregate Short Interest and Market Valuations.” American Economic Review, 94 (2004), 29–32.CrossRefGoogle Scholar
Newey, W. K., and West, K. D.. “A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix.” Econometrica, 55 (1987), 703–708.Google Scholar
Sadka, R. “Liquidity Risk and the Cross-Section of Hedge-Fund Returns.” Journal of Financial Economics, 98 (2010), 54–71.Google Scholar
Shleifer, A., and Vishny, R.. “The Limits of Arbitrage.” Journal of Finance, 52 (1997), 35–55.CrossRefGoogle Scholar
Sias, R. W. “Volatility and the Institutional Investor.” Financial Analysts Journal, 52 (1996), 13–20.Google Scholar
Sias, R. W. “Institutional Herding.” Review of Financial Studies, 17 (2004), 165–206.CrossRefGoogle Scholar
Xiong, W. “Convergence Trading with Wealth Effects.” Journal of Financial Economics, 62 (2001), 247–292.Google Scholar
Xu, Y., and Malkiel, B. G.. “Investigating the Behavior of Idiosyncratic Volatility.” Journal of Business, 76 (2003), 613–644.Google Scholar
Supplementary material: PDF

Kang supplementary material

Appendix

Download Kang supplementary material(PDF)
PDF 769.2 KB